The Blogosphere Banking Panic (I.)

There have been recent blog posts which imply a panic in the banking sector worse than the Great Depression, with highly respected financial writer Mish a/k/a Mike Shedlock making the extraordinary claim that "The entire US banking system is insolvent." His essential reasoning:

There is roughly $6.84 Trillion in bank deposits. $2.60 Trillion of that is uninsured. There is only $53 billion in FDIC insurance to cover $6.84 Trillion in bank deposits. Of the $6.84 Trillion in bank deposits, the total cash on hand at banks is a mere $273.7 Billion. Where is the rest of the loot? The answer is in off balance sheet SIVs, imploding commercial real estate deals, Alt-A liar loans, Fannie Mae and Freddie Mac bonds, toggle bonds where debt is amazingly paid back with more debt, and all sorts of other silly (and arguably fraudulent) financial wizardry schemes that have bank and brokerage firms leveraged at 30-1 or more. Those loans cannot be paid back.

What cannot be paid back will be defaulted on.

Is he right?

I'll have lots to say about Mish's reasoning and conclusion below.

But first, in addition to Mish's post, after a seemingly inconspicuous article noting that Key Bank set aside $1.4 billion to deal with bad real estate loans, with an analyst saying "The loss rates are just astronomical", another Apocalyptic blogger copied the story with the comment that

The rate of failure among the approximately 8500 US banks is about to start accelerating, probably in large and fast steps.

After the failure of Indymac two weeks ago, this second statement then morphed into another highly recommended entry on a very large site, authored by a diarist who admitted that he knows "jack s**t" but nevertheless declaimed that:

The FDIC is an insurance operation.... They’ve got $51 billion ... and Indymac alone sucked up 10% of that. If a big one lets go, like Washington Mutual or Wachovia, then the FDIC will look just like FEMA did facing down hurricane Katrina.
.....
Run, don’t walk, to your bank and get the funds you have clear of this mess before it gets any worse....

.... A lot of folks got trimmed in the Indymac crash, with $BIGBUCKS reset to the $100,000 maximum and no recourse. Once this truly gets rolling there will be a reduction in the amounts covered and probably withdrawal limits even with solvent banks.
...
The FDIC admits to prepping for a hundred, the highest estimate I've seen is 1,500 gone of the 8,500. Size matters; if it's only a hundred but it's the hundred largest, well, that would be grim.

Thus did one generic story about distress, and the failure of one admittedly large bank, lead to a feeding frenzy of 600 comments calling for money to be stored in the back yard or in mattresses, or converted into gold. (As we will see later, the blogger was certainly correct about one thing: how much he knows).

Even Russ Winter is now cautioning against placing trust in FDIC protection, although to his credit he is not going with the herd, and is seriously scrutinizing individual banks' conditions.

Thus has one of the great accomplishments of the New Deal, namely, FDIC insurance, a system that has given savers' confidence for 75 years, been consigned to the dust bin with barely a sneeze even by bloggers who call themselves "progressives."

The blogosphere talking points were best summarized in Mish's 25 point presentation noted above. Rather than repost the entire article, they can be summarized as:

spokespersons are defending the solvency of the system. This means it is insolvent (Points 1,2, 23)

Fannie and Freddie (which are not covered by FDIC) may be in trouble (points 5-7)

Finally, "in a Northern Rock moment, depositors at Indymac pull out their cash. Police had to be called in to ensure order." (point 3).

Actually, what happened is that

Police were dispatched to IndyMac Bank branches in suburban Los Angeles on Tuesday morning when customers waiting to withdraw money became irate after several people tried to cut in line on the second day of the failed institution's federal takeover."

People were upset by others jumping in line ahead of them. Oh. By that standard we must have been at full fledged Armageddon when 4 people were shot by others impatient waiting in line in 2006 in Kentucky waiting for the newest Nintendo game player!

But, is the FDIC insured banking system in trouble? After all, it did just spend about 10% of its fund on failed banks whose deposits constituted kess than 1% of the system. Will FDIC be able to pay off depositors in all but the most Armageddon-like scenarios? That will be the subject of following installments.

Tomorrow: A history of the FDIC

(I would like to gratefully thank Rob Oak for extensively assisting in the research and editing of this series)